Bondholders Sue Puerto Rico As Debt Talks Falter

A group of hedge funds in New York that invested in Puerto Rico general obligation bonds are suing the island’s government. The bond lawsuit came just days before the island is expected to default on a $2 billion debt payment due, including over $700 million in general obligation bonds on July 1, and on the same day that the island announced it was ending talks with bondholders about debt payments.

The negotiations has resulted in a number of failed proposals and counterproposals, but no resolutions. The U.S. Commonwealth continues to owe $70 billion in public debt, including $12.5 billion in general obligation debt.

The hedge funds’ complaint seeks to invalidate a law allowing Puerto Rico Governor Alejandro Garcia Padilla to put into effect a temporary debt moratorium. The bondholders contend that when they purchased the general obligation bonds, they had counted on the protection that was supposed to guarantee the bonds under the territory’s constitution.The hedge funds are arguing that they are entitled to be paid first—and in full—and on time. They claim that the the moratorium cannot be applied to the bonds that they hold. Also, the hedge funds are accusing the Puerto Rico government of improperly diverting tax revenue to the Puerto Rico Sales Tax Financing Corp. (COFINA) so more debt could be issued while bondholders were not paid.

Governor Padilla said the emergency debt moratorium would cover certain notes that Puerto Rico has issued. Padilla noted that this was essential for protecting his government’s ability to provide the island’s essential services and to ensure the well-being of residents. The executive order applies to certain PRIFA notes. PRIFA is the Puerto Rico Financing Authority.

With the executive order, all obligations to move funds or revenues related to PRIFA bond anticipation notes have been suspended. The notes are now covered obligations under the Puerto Rico Emergency Moratorium and Rehabilitation Act. Recently, Fitch Ratings downgraded Puerto Rico’s issuer default rating and related debt ratings from CC to C.

Some investors were even encouraged to borrow money so they could invest more into bonds or bond funds. When the bonds fell drastically in 2013, these investors sustained substantial losses. Some investors lost everything.